Worldcom scandal
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WorldCom started as a small long distance provider in 1983 and grew rapidly through acquisitions to become the second largest telecom company by 1998. However, falling revenues due to the dot-com bust and merger failures led to huge pressure to meet Wall Street expectations. WorldCom's leaders, including CEO Ebbers, resorted to fraudulent accounting by misclassifying operating expenses as capital expenditures, hiding $3.8 billion in losses. An internal audit uncovered the fraud in 2002, leading to WorldCom filing for bankruptcy, destroying $180 billion in shareholder value and costing 57,000 employees their jobs. Ebbers and other executives faced legal consequences for their role in the massive accounting scandal.
Worldcom scandal
- 1. BY: SHWETANSHU GUPTA MBA-49-2013 As it turns and burns
- 3. Company’s profile 1998- WorldCom and MCI announced its merger 1993- 4th largest with $1.5 billion revenue 1988-1994- Acquired more than half-dozen communication companies 1994- LDDS acquired IDB WorldCom 1995: Changed its name to LDDS WorldCom Started as a small long distance service provider called LDDS in Mississippi in 1983.
- 4. Cont’d From 1988-2002- 70 mergers and acquisitions purchased 30 companies Second largest telecommunication provider in the US after AT&T in 1998 and 2002. 2000- Both companies terminated the merger process. MCI WorldCom renamed itself simply "WorldCom". 1999, Sprint and MCI WorldCom announced a merger agreement, but remained unsuccessful. Number two telecom company in 1998 after MCI merger ($34.5 billion).
- 5. Year: 2002
- 6. According to a Wall Street Journal article on Feb. 29, 1996, WorldCom provided investors with returns of 57.3 percent a year over the previous 10 years. The article states: "A $100 investment in WorldCom in 1989, for instance, would be worth $1,580 by January; that, according to the company, is about 10 times the best return generated by WorldCom's primary competitors, the Big Three of long distance: AT&T Corp., MCI Communications Corp. and Sprint Corp.―
- 8. How started? • As WorldCom was enjoying name and fame there was huge pressures both externally and internally to be no.1. • Competition • Merger or acquisition • Expenses of line costs • Sprint demerger • Pressure to meet expectation of Wall street
- 9. Line costs? WorldCom customer in Chicago WorldCom customer in London Local network in Chicago WorldCom’s network British network
- 11. Cont’d WorldCom and other telecommunications firms have faced reduced demand as the dot–com boom ended and the economy entered recession. Revenues fall short of expectations, while debt remains. With failure of sprint merger it faced a severe setback. Shareholder’s expectation Profits Market value of the company’s common stock plunged from about $150 billion in January 2000 to less than $150 million as of July 1, 2002.
- 12. Dot-com boom- bust? The dot-com bubble -1997–2000. Marked by the founding of a group of new Internet based companies commonly referred to as dot-coms. Companies could cause their stock prices to increase by simply adding an "e-" prefix to their name or a ".com" to the end, which one author called "prefix investing".
- 13. Fraud First, WorldCom's accounting department underreported 'line costs’ Second, The company inflated revenue by $ 1 billion.
- 14. • A company spends $500 to perform annual maintenance on a cutting machine. This expenditure is an operating expenditure and, as such, it should be treated as business expense .Current net income would decrease as a result. • However, if the company spends $500 to replace the motor in the machine, this expenditure would be posted to the asset account ―Property, Plant, and Equipment‖. Such an expenditure is a capital expenditure because the life of the equipment has been extended and/or its operating efficiency increased. EXPENSE VS CAPITAL EXPENDITURE
- 15. What WorldCom did? Reduced the amount of money held in reserve by $2.8 billion and moved this money into the revenue line of its financial statements. In 2000, classified operating expenses as long-term capital investments ( $3.85 billion). These changes turned WorldCom's losses into profits to the tune of $1.38 billion in 2001. It also made WorldCom's assets appear more valuable.
- 16. They also added a journal entry for $500 million in computer expenses, but supporting documents for the expenses were never found. Ebber also takes out a separate $43 million loan to finance the purchase of a 500,000-acre ranch- backed by Ebbers' WorldCom stock. Scott Sullivan misallocated capital expenditure as normal expenses, thus turning profits into losses ( $9 billion) - not discovered by internal auditor Cynthia Cooper until June 2002.
- 17. How discovered? Then Securities and Exchange Commission (SEC) launched an investigation. Firstly by WorldCom's own internal audit department- uncovered $3.8 b. of the fraud.
- 18. What revealed? When irregularities were spotted in MCI's books, the SEC requested that WorldCom provide more information. The SEC was suspicious as WorldCom was making so much profit, AT&T was losing money. An internal audit found that WorldCom had announced as capital expenditures as well as the $500 million in undocumented computer expenses. There was also another $2 billion in questionable entries. WorldCom's audit committee was asked for documents. Admitted to inflate its profits by $3.8 billion and not following GAAP, over the previous five quarters. A little over a month WorldCom filed for Chapter 11 bankruptcy.
- 19. Chapter 11 bankruptcy Chapter 11 is a chapter of the United States Bankruptcy Code, which permits reorganization under the bankruptcy laws of the United States. Chapter 11 bankruptcy is available to every business, whether organized as a corporation or sole proprietorship, and to individuals. When a business is unable to service its debt or pay its creditors, the business or its creditors can file with a federal bankruptcy court for protection under either Chapter 11.
- 20. Present condition The company emerged from Chapter 11 bankruptcy during 2004 with about $5.7 billion in debt and $6 billion in cash. On August 7, 2002, the exWorldCo 5100 group was begun. It On February 14, 2005, Verizon Communications agreed to acquire MCI for $7.6 billion. December 2005, the Microsoft announced that MCI will join it by providing Windows Live Messenger customers "Voice Over Internet Protocol" (VoIP) service. This was MCI's last new product—- called "MCI Web Calling". After the merger, this product was renamed "Verizon Web Calling".
- 21. Consequence • Stock • Mid 1999 -$64.50 a share • After announcement - below $1 a share • Today -$.06 a share • Employees 57,000 employees lost jobs. • Shareholders $180 Billion of shareholder value lost. • Company $750 Million settlement paid to SEC
- 22. Legal trials